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Update to Business Combination Accounting — ASU 2017-01

Jul 01, 2019

The business world is constantly moving. Mergers, acquisitions, spin-offs, start-ups and private equity groups are more present than ever. We live in a time where “everything is for sale for the right price.” That said, it is important to have a good understanding of the accounting for business combinations. 

Recently, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2017-01 Business Combinations (Topic 805): Clarifying the Definition of a Business. The new standard darkens the line between acquiring a business and simply acquiring assets. The resulting accounting is extremely different on whether we come to the determination that we acquired a business versus made an asset acquisition. The below chart highlights some of these differences:


Business Combination

Asset Acquisition


Only arises in a business combination

Do not recognize goodwill; allocate excess consideration to the identifiable net assets acquired

Bargain purchase amount

Recognize immediately in earnings

Allocate on a relative fair value basis to identifiable assets and liabilities

Measurement of resulting assets and liabilities

Recognize at fair value

Allocate purchase consideration based on relative fair values

Transaction costs

Expense as incurred

Add to the cost of the assets acquired

Acquired in process R&D

Capitalize as intangible assets

Expense (unless it has an alternative future use)

OK, so what changed? 

Prior to ASU 2017-01, a business was defined as an integrated set of activities and assets (inputs and processes) that are capable of being managed to produce outputs. The old definition allowed for a concept of “market replacement” to substitute in order to produce outputs. 

This definition resulted in a determination that many acquisitions had to be accounted for as business combinations rather than asset acquisitions. For example, if your company wanted to purchase a building in a new location with the intent to move into that building, under the old definition, if there were tenants in that building, you just acquired a business. 

Based on this, the FASB updated the process in determining whether an acquisition is a business or an asset. The new guidance removes the “market replacement” concept and applies a two-step process. 

The first step is to determine whether “substantially all” of the assets acquired are concentrated in a single asset or a group of similar assets. If yes, the purchase is considered an asset acquisition and we do not move to step two. In the example above, the building acquired satisfies this test, and thus we would determine we have an asset acquisition and would account for the purchase as such. 

If we do not satisfy step one, we need to move to step two of the determination. 

Step two requires there to be at least one substantive process that contributes to the ability to produce outputs (revenue) in order for the resulting purchase to be considered a business combination. There are two separate determinations to be made at this step. First, if the acquired set is already producing outputs (revenue), the set only needs to satisfy oneof the requirements below:

  • Employees that form an organized workforce
  • An acquired contract that provides access to employees
  • A process that cannot easily be replaced
  • A process that is considered unique or scarce

If one of the four requirements above is met and the acquired set is producing outputs, we have ourselves a business acquisition. If no outputs are being produced (e.g., a start-up company that has a lot of research and development but not revenue to date), then the bar is raised. In this situation, we must have acquired a workforce with skills, knowledge and experience that is not easily replaced. If we do not have this workforce in place for a company without current outputs, we have an asset acquisition, not a business combination.

If we determine that we have a business combination and ASC 805 applies, we need to follow the five-step model to account for the business combination:

1. Identify the acquirer

This may seem simple, and it is in most cases, but it can get tricky in a true 50/50 merger situation. In a case like that, you would have to look to “tie-breaker” situations. Factors like pre-merger size, relative voting rights after the merger, and composition of the new management and governing body are all indicators of who would be treated as the acquirer and who would be treated as the acquiree.

2. Determine the acquisition date

Another easy step. This is the date that the acquirer obtains control over the acquiree. Typically, this coincides with the closing date. Do not confuse this with the announcement date or the date that negotiations are completed.

3. Classify and measure the consideration transferred

In most cases, the consideration transferred will be the sum of the cash paid at closing, the non-cash assets transferred, the liabilities incurred (debt and future consideration), the value of stock issued, and the value of stock awards (if issued to replace current awards). The tricky areas here are contingent consideration and stock awards. Please consult with an expert, as these areas are very technical and beyond the scope of this article.

4. Recognize assets acquired and liabilities assumed at fair value

That’s right, fair value. Fair value may vary significantly from the number stated on the acquiree’s balance sheet. For example, if part of what you are acquiring is inventory and the acquiree has inventory stated on their books at lower of cost or net realizable value (in accordance with GAAP), you will undoubtably see the resulting inventory at an increased value on the acquirer’s balance sheet moving forward. A similar situation will likely occur with property and equipment.

Some areas are trickier than others to value at fair value, and often a valuation specialist will need to be brought in to assist with the calculation. 

5. Recognize goodwill

This is a purely mathematical computation. Once you know the fair value of the assets acquired and the liabilities assumed (see step 4), the net of that amount is compared to the consideration transferred (see step 3). If the consideration transferred is greater than the fair value of the net assets acquired, the resulting amount is considered goodwill. 

There are circumstances where the fair value of the net assets is greater than the consideration transferred. In that rare instance, you would have a bargain purchase gain, which is recognized immediately into current earnings. Bargain purchase gains are rare, so it is recommended that you review the calculation of fair value and verify that you didn’t either omit or undervalue a liability or that you didn’t potentially overvalue an asset. Bargain purchase gains are most present when an entity is rushed into selling for one reason or another and cannot take their time to obtain the best deal.

Staying up to date

Business combinations are becoming more and more common throughout the world, so it is imperative to stay up to date on the proper accounting for these transactions. If your business is going to be involved in one of these transactions in the future, we recommend reaching out to your Wipfli relationship executive early in the process to stay on top of and better control the results.


Steven A. Jordan, CPA
Senior Manager
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